Stocks May Free Fall If Fiscal Cliff Deadline Is Missed

Though analysts say the markets see January 1 as a "soft deadline."

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The turbulent fiscal cliff negotiations may have shaken the stock market last week, but they haven't really unnerved investors – at least not yet. Analysts say that could still change, though, and stocks may take a tumble if negotiations break down and the nation is subjected to an extended economic hit from the tax hikes and spending cuts scheduled to take effect in 2013.

"The market is still being supported by the fact that we haven't yet crossed over to January 1st," says Mark Luschini, chief investment strategist at Janney Montgomery Scott. "But if this bickering and acrimony continues without resolution to the fiscal cliff into January then I think that becomes a more prominent concern."

Investors, who for weeks remained hopeful that a deal would be reached, have lately showed signs of increasing jitters about the cliff, with stocks seeing some sharp swings in recent days as the result of rumors and news about the troubled negotiations. Luschini notes that the stock market also slumped in the days after President Obama's re-election last month as investors began to price in the probability of going over the fiscal cliff. But the S&P went on to gain nearly 7% from November 15 to December 18. "Equity investors were basically trading the market up on hope," he says, "as opposed to any evidence and any track record by our elected officials that gives one reason to think they will work together without market pressure being applied."

More recently, as the last days of the year dwindled away without real signs of progress from Washington, stocks fell for five straight trading sessions through Friday. The Standard & Poor's 500-stock index (INDEXSP:.INX) and the Dow Jones Industrial Average (INDEXDJX:.DJI) both lost more than 2.8% over that period. The losing streak – the worst such stretch in months – has dragged both indexes into negative territory for December, traditionally among the strongest months for stocks.

Market volatility has also increased in recent days. The Chicago Board Options Exchange's Volatility Index, or VIX, spiked nearly 17 percent on Friday, it's biggest one-day move since November 2011. Over the last two weeks the VIX, often called the fear index, has risen 46%, though it remains far below the levels reached after Washington's contentious debt ceiling debate in the summer of 2011.

"The last couple of days of volatility are more indicative of what we should expect to see," Luschini says. "And that [the stock market] hasn't sold off more, in my opinion, is only due to the fact that there is still a day left in the calendar until we roll over to 2013."